What Is a Non-Recourse Loan
Upon discussing loans with the lender, some clauses are subject to negotiation such as the amount of the loan and the interest charged. A common clause is the non-recourse clause, indicating that the lender will not hold the borrower liable if he or she defaults on the loan.
Non-recourse loans differ from personal loans, where the lender may hold the borrower responsible for the borrowed amount. Purchase loans for one’s primary home may also be regarded non-recourse debt. On the other hand, second mortgages, refinance debts, and cash out transactions typically fall into the category of recourse loans.
In addition, not all non-recourse loans are identical. For example, non-recourse clauses in some loan agreements indicate the specific circumstances under which the lender will not hold the borrower liable in the event of default. Borrowers are held personally liable in case that they have carried out a project resulting in environmental pollution or when they are guilty of fraud. Such types of loans are sometimes referred to as limited recourse loans.
While non-recourse loans free borrowers from corporate liability, the lender has ownership rights over the property used as collateral
. The lender has interest in the property serving as a guarantee for the loan but cannot take legal action against the borrower. The lending institution
cannot hold the debtor responsible even if the proceeds from the sale do not pay off the financial obligation. For this reason, non-recourse debt is usually limited to a 50 or 60 percent loan-to-value ratio, so that the property value is sufficient to pay off the loan.
, non-recourse debt is typically used for the financing of major projects by the government or quasi-government institutions. For example, infrastructural projects such as toll roads, hospitals, or power generating plants are usually completed by resorting to non-recourse debt. Commercial real estate projects such as the construction of buildings and shopping malls are also financed by this type of loans. In general, non-recourse debt is used for projects with long loan periods, high capital expenditures, and uncertain revenue streams.
Non-recourse loans may come with certain requirements such as making a higher down payment or having a certain amount of money set aside. Lenders try to make sure that there is a degree of certainty they can recoup potential losses if borrowers default on their loans.
It is important to note that non-recourse loans come with certain risks. While borrowers may lose the collateral on default, businesses will be concerned with the effect of defaulting on their balance sheet. In general, non-recourse debt is reflected as liability on the balance sheet, with the collateral being carried as an asset. Upon default, the asset is considered lost for the time being. In other words, there will be no gain on the balance sheet despite that additional funds are coming in. In fact, a low loan-to-value ratio may be reflected as loss on the balance sheet after the financing has been obtained.